Outlook: Focus on Multiple-Year Selling

January 4, 2011 07:29 PM

As we start the new year, I’d like to take stock of what we learned in the one that just ended. In this time of growing technology marvels, we were again reminded that weather is the big player in marketing decisions. While corn hybrids are better, we still need cooperative weather all season long to have the yields that match. Final production figures for 2010 will be out later this month; I expect corn will be down a little and soybeans will remain stable. In 2011, weather will play a major part in pricing, especially from April to August. With tight domestic stocks, we must have normal crop yields.

We are in a demand-driven environment. By this I mean we are experiencing absolute growth—rather than moving along the demand curve—in ethanol and corn and soybean exports, primarily due to China. This surge of demand started in 2001 and has consistently grown in the past 10 years; supply has not been able to surge fast enough to offset it.

While economic incentives will eventually stimulate supplies, I don’t believe it’s in the picture for 2011. China may be a strong buyer of corn and soybean exports in the first half of 2011. However, if reductions emerge in Argentina’s corn crop or Brazil’s soybean crop, exports could be even stronger than the current bullish estimates. I fear market action from May to July could be extensive enough to surpass 2008 prices if there are any planting delays this spring.

A change in Washington. The time of uncontrolled spending is coming to
an end as people realize that government spending is not creating the jobs that the private sector does.

I’m concerned that there is a growing dislike of ethanol in Washington. Environmentalists do not like it, end users do not like it and politicians will look for areas to cut with the least political fallout. While there is a temporary extension on biofuel credits, this support could easily drop to the sidelines if we have a strong price event this year. Ethanol plants must use profits to reduce debt, rather than expand. Betting on government support past 2012 would not be wise. If we get an unexpected price event, those of you who grow corn should be equally motivated to protect long-term profits.

Future strategy. Today’s price action reflects much of the activity in the 1970s. Demand growth
relies on increasing Chinese exports. I expect exports will be strong, but China does not want to become dependent on grain imports like we are dependent on oil imports.

Through the 1980s and 1990s, it was wise to forward sell inventory. Recently, early selling has proven to be costly because of unexpected strong demand. While I always try to be a strong forward seller, 2011 is a year to exercise caution in your merchandising programs.

Lay off risk by April. Don’t enter into an "all or nothing" approach by selling cash or straight futures. Instead, be flexible from April to July. If a weather event occurs, you should be able to gain from it or, at the very least, have a floor under the market. This implies creating a put strategy to market grain.

There are several ways you can do this:

  1. Buy a December corn put and a November soybean put and stay unpriced in the cash. While this does have a high premium cost, it gives total flexibility of the cash production process.
  2. If production is very predictable (because of irrigation, for example), you could forward sell in the cash market and buy a call to defend against upside exposure.
  3. If production is very uncertain or you don’t like buying puts, sell the futures but focus on buying in-the-money calls to defend upside risk.

Note that there are several variations of each of these strategies, but the core assumption is that you are going to spend money to lay off risk in order to be flexible enough to benefit from a May-to-July price jump due to bullish yield variability.

Summary. This year, the market can’t tolerate a yield reduction. If Mother Nature doesn’t cooperate, we could see prices higher than 2008 levels. Focus on multiple-year selling. If you can’t sell at the elevator because of margin call problems (which we anticipate many will encounter as they did in 2008), use futures contracts. Find a banker who understands hedging and will finance the plan if it gets salty, as well as a broker to work with as a hedge adviser, not a speculative trader.

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